It's sad but true. WisconsinAmerica's Dairyland, home of the Cheesehead,
national epicenter of udderscouldn't produce enough milk to meet
local demand in 2001. In order to reach production goals, Wisconsin cheese
producers were forced to ship in milk from as far away as Texas.

The inability of local dairy farmers to fully supply Wisconsin's cheesemakers
last year is a symptom of what many consider a crisis in the Midwest dairy
industry. And the decline of district dairy is a longand some say
inevitabletrend. Driven by technological advance and market consolidation,
the dairy industry has undergone dramatic change in recent decades. Thousands
of small dairy farms have gone out of business in Ninth District states,
cow inventories have plummeted, milk production has dropped, and the center
of dairy gravity has shifted relentlessly from the Midwest to the West
Coast.

But dairy farmers in the Ninth District aren't admitting defeat, and
their recent responses to the decline have ranged from large-scale growth
to innovative development of small-scale dairy niches. Wisconsin and other
district states may never regain the title of America's Dairyland, but
these farmers hope they might just stop the downward flow of Midwest milk.

No more moo?

For most of the 20th century, Wisconsin was the nation's top milk producer.
A climate favorable to good forage and a culture of skilled dairy farmers
producing quality product for local processors guaranteed steady growth
to the industry and comfortable profitability. Similar assets made Minnesota
a leading milk producer as well.

Although cow numbers in district states have actually been declining
for decades, the more worrisome trend since the late 1980s has been the
faltering of total milk production. From a high of nearly 25 billion pounds
of milk in 1988, Wisconsin production dropped 11 percent by 1997. Minnesota
milk production dropped 12 percent during the same period, and other district
states (far smaller producers of milk) dropped even more. Meanwhile, California
increased production by 48 percent and other Western states showed similar
growth trends. By 1994, California had surpassed Wisconsin as the nation's
largest dairy producer and by 1998 was providing almost a fifth of the
nation's milk.

"[We're] talking about a crisis that's taking place in Wisconsin,
and it's similar elsewhere in the Upper Midwest," noted Hank Wagner,
board president of the Professional Dairy Producers of Wisconsin (PDPW)
and owner of a 450-head dairy farm in Oconto Falls. "Dairy is rapidly
leaving our state and growing in other parts of the country, so the crisis
that is really taking shape is we're losing infrastructure, we're losing
dairy farmers, and we're losing a lot of the income, the money that is
put back into our state's economy."

Indeed, last year's Wisconsin milk shortage was the result of a downward
death spiral of milk supply and processing capacity: As milk farmers go
out of business, local processors faced with excess capacity are forced
to import from other states. They pay premium prices to cover the transportation,
and their higher costs soon force them out of business, too. One analyst
calls it "a dismal iterative process" in which Wisconsin loses
scores of cheesemakers and other dairy processors just as it loses thousands
of dairy farmers.

Source: U.S. Department of Agriculture

The reasons for the Upper Midwest's decline as a milk producer are complex
and often disputed. A steady fall in milk prices and consolidation among
dairy processors and retail groceries (see "Dairy Concentrate"
story below) are often highlighted as the causes. But the central question
is why dairy farms in the Upper Midwest have wilted while Western dairiesfaced
with similar prices and equal levels of consolidationhave prospered.
And the answers have a lot to do with economies of scale and both the
willingness and ability of local dairy farmers to seek them out.

Dairy Concentrate

Part of the downward pressure on milk prices, according to some,
is due to the power wielded by buyers, who have become fewer in
number and greater in size, reflecting dramatic consolidation within
the dairy industry similar to that seen elsewhere in agriculture.

According to the U.S. General Accounting Office (GAO), the market
share of the top four dairy cooperatives increased from 72 percent
to 77 percent between 1997 and 1999. The top four dairy wholesalers
increased their market share from 69 percent to 76 percent over
the same period. At the retail level, according to the National
Milk Producers Federation, the top 10 supermarket chains control
52 percent of retail grocery sales, nearly twice their market share
in 1987.

Currently, two of the nation's major dairy companies, Suiza and
Dean, are in the final stages of a merger that would give the combined
company nearly a third of the US milk market. Decrying the merger,
US Sen. Patrick Leahy of Vermont told the press that the merger
would be a disaster for consumers and for farmers, "who can
expect to be offered even lower prices for their labor and their
products."

Concentration levels have clearly risen significantly in US dairy,
but whether this concentration has created effective market powerthat
is, the ability of buyers or sellers to influence pricesis
unclear. Because of the complexity of the milk market, academic
researchers have found it difficult to reach solid conclusions about
the relationship between dairy industry consolidation and market
power in milk. "When taken together, we found that these studies
had mixed results," said the GAO in its June 2001 review of
dairy industry prices and market structure. "While some studies
reported that the increased concentration could lead to greater
market power and higher prices, others noted that the increased
concentration led to greater economies of scale and lower costs."

Shrinking profits, fewer farms

"The backbone of the Midwest dairy industry is the small family
dairy, with 50 to 60 cows, and they're having difficulty competing,"
noted Paul Christ, a dairy industry consultant and former vice president
at the Land O'Lakes dairy cooperative based in Arden Hills, Minn. "Milk
prices in nominal terms have not increased." And when inflation is
taken into account, prices paid to dairy farmers actually have fallen
while their costs of production have increased.

As dairy profits have declined or disappeared, less efficient producers
have gone out of business, leading to dramatic drops in numbers of dairy
farmers. Wisconsin lost 38 percent of its dairy farms in the last decade
as roughly 13,000 dairy farms went out of business, leaving approximately
21,000 dairy operations today. The number of Minnesota dairy operations
dropped 43 percent in the same period, from 15,000 a decade ago to about
8,500 currently. Small district dairy regions have suffered as well. Local
officials in Michigan's Upper Peninsula estimate that there are just 200
dairy farms left in the U.P. currently, down from 460 in 1980.

Long-term dairy farm trends have been far worse than farm trends generally.
According to the USDA's agricultural census, while the number of all farms
in the United States declined by half from 1959 to 1997, the number of
farms with milk cows declined by over 90 percent.

How beautiful is small?

As dairy operations have struggled to survive, politicians and farm advocates
have called for action to support small dairy farms. Last May, for instance,
US Rep. Ron Kind of Wisconsin proposed incentive payments for dairy farmers,
saying that otherwise "America risks losing the family dairy farms
that have made us so strong."

Such efforts may prolong the lives of traditional-scale farms, but they
won't reverse the economic realities of dairy production. The fact is
there are huge economies of scale in milk production, and dairy farms
in the West have taken advantage of them. Midwest farmsuntil recentlyhave
not.

Technological advances in dairy productionfrom automated milking
parlors to computer systems and management protocolshave dramatically
increased dairy productivity, the number of pounds of milk a cow can produce.
The average cow can produce four times more milk today than in 1930. But
those technologies are most economical on large-scale operations, and
small farmers have been unable or unwilling to grow large enough to incorporate
them. A 1998 Minnesota State Colleges and Universities analysis of Minnesota
dairy farms found that small dairy herds (under 100 head) averaged 17,699
pounds of milk per cow per year, whereas cows in large herds (300+) produced
21,284 pounds.

As a result, Midwest dairy farmspredominantly smallhave fallen
behind in the milk productivity race. While California cows produce an
average of 21,169 pounds of milk per year (16 percent above the national
average of 18,204), Wisconsin cows produce just 17,306 and Minnesota cows
produce 17,777.

So why have local farmers tended to stay small, despite the apparent
advantages of larger operations and new technology? At least three reasons
are clear: federal policies, financial constraints and cultural barriers.

Source: U.S. Department of Agriculture

Federal protection program

With the philosophy that every region and even every state should support
its own dairy industry, federal policymakers for years propped up dairy
prices at artificially high levels by agreeing to purchase surplus dairy
products. Surplus cheese and milk powder was bought by the government
and fed to school kids or sent overseas as part of the Food for Peace
program.

With protection from true competitive prices, small dairy farmers had
little incentive to seek efficiencies and, therefore, little need to grow.
When surplus purchases and price supports were reduced in the mid-1980s,
milk prices dropped dramatically. In Wisconsin, for example, real milk
prices fell from a peak of about $28 per hundredweight in 1979 to roughly
$15 during the 1990s (in 2000 dollars). The price drop began to squeeze
profits for dairy producers and the least efficient of them were forced
out of business.

Lack of capital

Another factor has also played a significant role in preventing the expansion
of the district dairy industry. Christ and other analysts note that even
if a local dairy farmer wanted to expand the scale of his operation, a
lack of ready access to capital has dimmed prospects for growth.

"The trouble is that we don't have a very good financial base,"
said Christ. "The only source of financing has been personal equity
and bank loans, and the banks have required a fairly large percentage
of equity."

A new or expanded dairy operation could easily cost around $5,000 per
stall, including the cow. "So if you're talking a 1,000-cow deal,
well, you're talking about a $5 million project," observed Harold
Stanislawski, a Minnesota Department of Agriculture business adviser based
in Fergus Falls. "A lot of banks, they'll say, okay, in order to
make this work, you better bring 45 percent equity to the table. And you
know, that's hard to do."

California farmers, say analysts, were able to self-finance by selling
off portions of their land, which appreciated rapidly in the West in the
1980s and 1990s. Upper Midwest farmers, by comparison, have had less equity
and were less able to self-finance. Instead they've had to rely on the
Small Business Administration's 504 program and USDA grants or loans.
But such programs, designed years ago, provide limited capital. "Outmoded
and outdated," Stanislawski said.

Small minded?

While federal subsidies diminished the need to increase efficiency and
lack of capital curbed the impulse further still, dairy farmers in the
Upper Midwest have faced an obstacle to growth that never challenged California
farmers: the powerful cultural tradition of the small, family-based dairy
farm.

"I think there's been an important structural barrier, which was
the notion that small is beautiful and big is bad," observed Al Mussell,
senior research associate at the George Morris Centre, a Canadian agriculture
think tank. Mussell analyzed the economics of the Upper Midwest's dairy
industry as a doctoral student at the University of Minnesota. "A
typical Minnesota or Wisconsin dairy farm was mom and pop and a couple
of kids, 50 cows and 200 acres. There were certainly times when farms
like that could be fairly profitable, but as a sustainable business venture
... it looks pretty bad."

Mussell says the problem has been one of undercapitalization. There was
"a culture in the Upper Midwest dairy industry that we've got a sustainable
kind of family farm unit, and there's no need to go out and assume a whole
bunch of overhead to try to get scale economies," he observed. Small
dairy farmers in the Upper Midwest have tended not to believe that such
economies truly exist, says Mussell, "when in fact, they're very
large, and they just didn't get adopted."

But unwillingness to grow in scale and invest in new technologies kept
dairy farms in the Upper Midwest from improving productivity and maintaining
competitiveness. "There are a lot of dairy farmers who are doing
things today the same way that their parents did 'em 50 or 100 years ago,"
said PDPW's Wagner. "You can't do that and expect to have the same
success that you had 50 or 100 years ago." Wagner says dairy farmers
have to be far better managers than ever before because they face tougher
competition, and that implies approaching dairy differently from before.
"It means running the dairy farm as a business rather than running
it as a way of life."

Many district farmers are, in Stanislawski's words, "basically on
the status quo page and just trying to get to retirement and call it a
day." But others are bucking the trend, and there are signs of recovery
in local dairy. Some, with assistance from extension services, are maintaining
their basic scale of operation but increasing efficiency through new techniques
and management, including relatively inexpensive changes like the elimination
of stanchion or tie-stall barns in which cows must be led in, secured,
released and led out for each milking, requiring more time and labor than
freestall barns and milking parlors.

But two developments with broader consequences are an increasing trend
toward large-scale dairy operations in the district and the growth of
niche producers.

Dairy grandé

In 1996, Tom and Wanda Hogness milked 110 cows. Five years later, with
1,000 head, they have the largest dairy operation in North Dakota. According
to Wanda, the expansion was a gamble that paid off. "My husband's
always had his heart in dairy," said Wanda. "So when we had
an opportunity to expand, we thought, well, we're young, we can take a
chance."

The Hogness dairy farmnear Milnor, about 70 miles southwest of
Fargoemploys the equivalent of 20 full-time employees, turning Tom
into more of a manager than a milker, but freeing him from the grueling
schedule of the smaller operation. "Before it was seven days a week,
you know, morning [and] night milking," noted Wanda. "Now we
can get away. It's still stressful and everything, but when we look at
the difference between before and now, I guess we like it now."

Large dairy farms like the Hogness operation are exceptional in North
Dakota, but becoming closer to the norm for Wisconsin and Minnesota, where
about 25 percent of dairy farms had over 200 head in 2000, an increase
from under 6 percent in 1993. (By comparison, 97 percent of California
dairy operations are 200 cows or larger; in fact, 78 percent have over
500 head.)

Shane Goplin runs a 700-cow dairy farm with his father and brother in
Osseo, Wisconsin, and crops about 1,500 acres to feed the cows. They might
prefer a smaller operation, said Goplin, but steadily increasing costs
have squeezed margins and pushed them to increase herd size. "Profits
per unit goes down so you have to get more units" to make a living,
said Goplin. "We're still a family farm. It's just a larger family
farm."

Move west, young cow

Officials in western Minnesota and eastern South Dakota are also optimistic
about large-scale dairy. Stanislawski said, "About 15,000 dairy cows
have been put in the [western] corridor region" in recent years,
mostly on larger operations. Better technology drives the scale, he says,
but the balance sheet is the main influence. "If you can capitalize
these things profitably and productively, you're going to see that your
return on assets and equity are greater by having the scale there."

Stanislawski predicts that Minnesota's dairy belt will move from southeastern
and central Minnesota to western Minnesota and into South Dakota, driven
by high land prices in the former region and low feed costs in the latter.
Another westward draw is the recent announcement by Davisco, a Minnesota
company, to build a $50 million mozzarella cheese plant in Lake Norden,
South Dakota.

And the South Dakota Ag Producer Ventures farmer cooperative is pushing
a dairy development program that hopes to persuade farmers to buy "start-up
kits" for $4,000 that would provide them with development plans for
2,500-head dairies.

Nature's bounty

In a mature industry faced with low margins, the two key
strategies for survival are growth or specialization. Milk companies are
growing through acquisition and many farms are growing their herds. But
other farms are charting a future by developing high-profit dairy products,
differentiated from standard dairy by stressing organic production or
other more "natural" feeding or animal-raising techniques.

In 1999, four farmers with about 375 "contented cows" in southeastern
Minnesota formed PastureLand, a grass-fed dairy cow cooperative. Their
high-fat, hormone- and antibiotic-free milk is processed into butter and
cheese and sold in health food stores and food cooperatives at substantially
higher prices than comparable conventional products.

Across the Mississippi River, in La Farge, Wisconsin, a similar but far
larger cooperative, the Coulee Region Organic Produce Pool (CROPP), coordinates
organic product sales for 409 farmers in 15 states. CROPP sales, about
90 percent dairy, have grown from $9 million in 1995 to $100 million in
2001, and though organic milk constitutes less than 1 percent of total
US milk consumption, the growth trend represents a significant market
opportunity for a high-margin product.

Dan Pearson, a fourth-generation dairy farmer in River Falls, Wisconsin,
has been a CROPP member since 1996 and milks 75 organically fed cows.
"From a dairying perspective, we're small," admitted Pearson.
"The farms that I was keeping up with 10 years ago are now 200 to
400 cows. They've been growing constantly. But I guess probably just as
many of them aren't in business anymore."

Pearson pays more for organic corn and soy than a conventional dairy
farmer would for standard feeds, but he reduces costs by rotationally
grazing his cows on 8- to 10-acre pastures on the 160-acre farm. But while
cost reduction is essential, the true edge for Pearson and other CROPP
producers is the pricing advantage for their niche product. When prices
for conventional milk were down in 2000 to between $10 and $12 per hundredweight,
CROPP maintained an organic price of around $17. "That was a real
test for us," said Pearson. "Could we hold our price with the
regular price being down that low for that long? And we were able to hold
it. So that showed us that we have a different product." Indeed,
current retail prices for CROPP organic milk are 50 percent to 70 percent
higher than for conventional milk.

Doing things differently

Whether or not Midwest dairy farmers can thrive by cutting costs, getting
bigger and specializing their products will not be known for a while.
A pessimistic signal came from Land O'Lakes and Alto Dairy last year when
they decided not to build a new cheese plant in Wisconsin, concerned about,
among other things, insufficient milk supply.

But other observers are more optimistic. "Milk production has stabilized.
In the last four or five years, there has been a fairly dramatic recapitalization
in the dairy industry in Minnesota and Wisconsin. ... The long-run decline
in total milk production, I think, has probably reversed itself,"
said dairy analyst Mussell. "As best I can tell, the Upper Midwest
may have turned the corner on this."

Or as Wagner, of PDPW, put it: "There still is money to be made
in dairy. You just have to do things differently than you did 50 years
ago."